Red hot China

Chinese manufacturing expanded by the most in five years in December, supporting estimates that growth has accelerated to more than 10 percent in the world’s third- biggest economy...

“China’s economy is continuing a V-shaped recovery and economic growth may have quickened to 11 percent in the fourth quarter,” said Sun Mingchun, chief China economist at Nomura Holdings Inc. in Hong Kong. “There are early signs that the economy may be entering an overheating stage,” he added, citing rising raw-material costs and company inventories at high levels.

Chinese leaders are understandably reluctant to pull back on stimulative policies, including the renminbi peg, but inflationary pressures may force their hand. Consumer prices have only just begun expanding once more, but asset prices, including real estate values, have gotten rather frothy. James Hamilton links to other interesting developments in China including rampant hoarding of copper and garlic, among other resources. The latest data has also delivered a kick to oil prices, which have once more risen above $80 per barrel (though analysts also cite record cold and resulting energy demand for the uptick).

There has been an interesting debate between Paul Krugman and Scott Sumner on the nature of Chinese currency policy in recession. Mr Krugman has essentially declared the policy to be mercantilist—China is stealing demand from other countries and growing at their expense. Mr Sumner isn't exactly denying that there's a competitive dynamic to the currency policy, but he has pointed out that the renminbi peg is also expansionary, so while it may result in some diversion of economic activity it also increases global demand on net.

I was curious to see whether Mr Sumner had altered his view of the situation at all in recent weeks. It seems he has not:

For the moment let’s stop obsessing about our unemployment problem, and spare a thought for the millions of Chinese workers in coastal factories who were thrown out of work during late 2008 and early 2009. Who’s to blame for that crisis? I am pretty sure Krugman would say we are. He thinks that the financial crisis of 2007-08 was caused by reckless policies in the US and in some European countries as well. So we are to blame for the deflationary shock that hit the world economy in late 2008.

Now ask yourself what Keynesians think a central bank should do when faced with a deflationary world environment. Krugman’s hero Keynes said FDR was “magnificently right” when he sharply devalued the dollar in 1933, even though we had a trade surplus and even though Keynes was British. The devaluation was seen (correctly) as a way of reversing the deflation. And it worked. Indeed Krugman’s colleague Svensson called devaluation a foolproof way out of a liquidity trap, and recommended Japan adopt this policy. And Japan also has big CA surpluses.

But China did not devalue, just as they refrained from devaluing in the 1997-98 Asian crisis. All they did is temporarily halt their ongoing policy of currency appreciation. As a result they still suffered some deflation in 2008-09. Furthermore they adopted a massive fiscal stimulus, surely a policy that Krugman would approve of. So the combined effects of this fiscal stimulus (widely seen as the world’s most effective in this crisis), and the monetary stimulus provided by putting currency appreciation on hold, was still not enough to prevent deflation. But apparently this is still too much for Krugman. He favors an even higher value of the yuan, which would have meant even steeper deflation in China.

And for the most part, I am inclined to agree with him. But the datapoints shared by Mr Hamilton worry me. Mr Sumner suggests that rising Chinese real estate prices reflect not a bubble, but woefully inadequate housing supply growth. That may well be true. But perhaps growth in China is hitting its potential, at least in some sectors, which leaves excess liquidity sloshing around to pile into whatever asset class attracts the speculators' attention.

Tyler Cowen has, I believe, officially stated his belief in the "Austrian" over-investment nature of recent Chinese growth. I've pushed back against that idea somewhat, arguing that in a country with hundreds of millions of poor people, even double-digit growth seems unlikely to produce long-term overcapacity. To some, the idea that recent Chinese growth represents a bubble is obvious, but I don't think the matter is so clear.

I do believe, however, that the point at which it will become clear is fairly near. Either there are real aspects to Chinese growth, and it will soon begin to pull developed economies, including America's, out of the doldrums, or China is the world's next big bubble, in which case the garlic-hoarding stories will increase in frequency, inflation will rise, and China's government will have no choice but to allow the renminbi to appreciate. In either case, matters will soon work themselves out, and the worst thing America could do would be to create a whole new crisis by throwing up a bunch of tariffs.

Readers' comments

Thanks for the discusssion of my post. I should clarify that I only oppose Chinese currency appreciation while their economy is depressed from the world slump. At some point in the not too distant future they should begin appreciating their currency again. (6 to 12 months from now?) Obviously that will not reduce China's surplus just as the 2005-08 appreciation did not reduce China's surplus.

The one thing we should be grateful about with regard to China's behavior in Copenhagen is that they tipped their hand. They plan to play hardball, and to operate in no one's interest but China's. This is entirely within their rights to do, but other nations would do well to respond in kind. As a number of leading economic minds have indicated, China would come out serious losers in a trade war with the US. China needs US markets, and the US needs to consume fewer Chinese imports. A trade war would arguably offer as many long-term benefits to the US as costs.

Krugman's timing - writing as he does shortly after Copenhagen - is, I suspect, not a coincidence. To feebly channel W and Putin for a moment, I suspect he's seen China's "soul", and has not liked what he saw.

This is why Scott Sumner's arguments are fiddly and brush the outside of relevance of the core issues here. Further, to defend the Chinese peg, which amounts to a colossally huge domestic stimulus, all the while denouncing stimulus efforts at home, is just bizarre and inconsistent at the most basic level.

Of course, as econblog watchers know, Sumner's undisguised raison d'etre is self-promotion, praying to be noticed among econbloggers, and he has decided that to attack the widely-read Krugman at every turn is the best way to get links. So it's risky to take what he says too seriously as earnest thinking.

However, it will be interesting to see where the true thinkers come down on mercantilism and the Yuan over the next months.

But in my opinion, if China wants to ignore the interests of anybody but China, all other parties need to defend their interests as well.

I think Tyler Cowen and Washington are talking about different things. Cowen would be insulted to be lumped together with Austrian economists, but if he is thinking like an Austrian, which he rarely does, the over-investment isn't general but specific to industries. Washington is talking about general over-investment. The Austrian view on over-investment is that it the investment produces more consumer goods of a particular kind than what consumers want. Washington is thinking of macro aggregates while Austrians think in terms of specific industries.

It's very clear that the Chinese guv is wasting a lot of resources on office buildings and malls. Still, the private sector is dynamic enough to overcome that enormous waste. If real estate prices are soaring, it's probably due to too much money chasing a shortage of particular types of land, not buildings. I expect to see continued rapid growth in the private sector, enormous waste from the guv, and a steady increase in Chinese standards of living.

Keep in mind, too, that in conservative societies such as China, real estate is considered the safest investment. That's why Dubai soared the way it did. The Chines are showing their conservative nature by investing in real estate. Also, heavy investment in real estate indicates a lack of other investment opportunites, such as manufacturing, for the private sector.

i am sitting in nanjing, tonite -7C, 3rd cold winter in a row. those economists (krugman, etc.) theories sound more complicated than those climate models (but at least i sense a minimal amount of honesty in the economists' motivations). the weather has been fluctuating wildly for millions of years, but the economic situation is truly something we control and is something newly created by us. all that theory is too complicated for me, but i do know that while western governments cripple western business with endless regulation, taxes (given to people who dont work or businesses that are not competitive), etc., here people only want a chance to work for a living. i dont see any big correction coming in the average world temperature, but maybe a big correction in where business activity is hot.

Jer_X, don't you know? The extremes will become more extremist! That's why they talk about "climate change" now instead of "global warming." CO2 can create extremely low temps as well as extremely high ones. It's the theory that explains everything from flat tires to broken bed springs.